Higher interest rates boost lending margins at TD and CIBC

Higher interest rates boost lending margins at TD and CIBC

Two of Canada’s largest banks are reaping rewards from higher interest rates as profit margins on loans increased in their fiscal third quarter, though growing economic unease threatens to undercut some of those gains in the near future.

Toronto-Dominion Bank (TD) reported a lower third-quarter profit than in the same period a year ago, partly because of high costs driven by inflation and rising loan-loss provisions. Canadian Imperial Bank of Commerce (CIBC) also saw earnings dip in the quarter, faced with the same headwinds.

But both banks recorded good gains in net interest margins – the difference between what banks charge on loans and pay on deposits. Those profit margins were squeezed in the COVID-19 pandemic as central banks cut interest rates to ultralow levels. But central bankers have rapidly jacked rates up again to fight high inflation, which is allowing lenders to reprice loans and deposits and eke out more profit.

Banks expect margins will continue to increase in the coming quarters, albeit at a slower pace. They also acknowledged, however, that with inflation running high, borrowing costs rising and significant economic uncertainty, demand for new loans – especially residential mortgages – could dip. And banks expect loan defaults will start to creep higher, from unusually low levels.

“If all the forecasts are correct with respect to what will happen in the economy, with the rising rates, with the slowing down a bit of credit demand, you’re going to see a bit of offsetting of those factors,” said Hratch Panossian, CIBC’s chief financial officer, in an interview.

Between expanding margins and cooling demand for credit, however, “we’re confident that net interest income will continue having strong momentum going forward,” he said.

In TD’s U.S. business, the gains were much larger, with margins up 46 basis points year over year to 2.62 per cent. The bank’s heavy focus on retail consumers and commercial clients makes it the most sensitive to interest rates among Canadian lenders, and that has set high expectations for the boost TD will get from rising rates.

“The bar was set very high here and while TD did not leap over it, the bank did gingerly step over it,” said Meny Grauman, an analyst at Scotia Capital Inc., in a note to clients.

Banks are also still expecting a rebound in borrowing on credit cards, which are a high-margin product because they charge high interest rates. Spending levels on cards are back above prepandemic levels, with transaction volumes up 10 per cent year over year at TD and spending levels reaching a new record. But the balance customers carry on those cards is still lower than it was prior to COVID-19. When that borrowing bounces back, it could also help banks’ lending margins.

“We are seeing a lot of pent-up demand,” TD chief financial officer Kelvin Tran said in an interview.

TD earned $3.21-billion, or $1.75 a share, compared with $3.54-billion, or $1.92 a share, in the same quarter last year. But the bank also booked a $678-million accounting loss on a hedging strategy it is using to manage interest-rate risk related to its US$13.4-billion acquisition of U.S.-based bank First Horizon Corp., which is awaiting approvals from regulators.

Adjusting to exclude the hedging costs and other items, TD said it earned $2.09 a share, above the analysts’ consensus estimate of $2.04 a share, according to Refinitiv.

In the same period, CIBC earned $1.67-billion, or $1.78 a share, compared with $1.73-billion, or $1.88 a share, a year earlier. Excluding costs related to CIBC’s acquisition of retailer Costco’s credit card portfolio and other items, the bank said it earned $1.85 a share, whereas analysts expected $1.84 a share.

TD and CIBC joined National Bank of Canada as the three major lenders that have so far met or exceeded analysts’ expectations for the third quarter. Bank of Nova Scotia and Royal Bank of Canada’s profits fell shy of estimates, and Bank of Montreal reports next week.

In most cases, year-over-year profit comparisons have been hampered by increasing loan-loss provisions, weak capital markets results and rising costs. But underlying trends such as growth in loan balances and the health of consumer credit still look strong.

“Results are fairly solid in light of a challenging macroeconomic outlook,” said Rob Colangelo, vice-president and senior credit officer at Moody’s Investors Service, in an interview. “We could see some moderation in loan growth, you could see margins continue to expand. … Overall, the environment still bodes well for the banks.”

Even so, lenders are adopting a more conservative stance by adding provisions for credit losses to build reserves to cover loans that could default. TD added $351-million in provisions in the quarter and CIBC earmarked $243-million. In both cases, some of the increase was driven by changes to economic models that anticipate future problems with loans still being paid back today.

“This quarter, we have updated some of our economic scenarios to be more conservative,” TD’s Mr. Tran said. “There’s a lot of uncertainty in the market and we’re going to have to see how it plays out”


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